money and banking chapter 14

open market purchase

a purchase of bonds by the fed.

money multiplier

a ratio that relates the change in the money supply to a given change in the monetary base.

open market sale

a sale of bonds by the fed.

shifts from deposit to currency

affect the reserves in the banking system but no effect on the monetary base.

fed's balance sheet

assets: securities, loans to financial institutions liabilities: currency in circulation, reserves

float

cash items in process of collection at the fed minus deferred-availability cash items.

securities

covers the fed's holding of securities issued by the us treasury and in unusual circumstances other securities. the primary way the fed provides reserves to the banking system is by purchasing securities, thereby increasing its holdings of these assets. an increase in government or other securities held by the fed leads to an increase in the money supply.

currency in ciruclation

currency in circulation is the amount of currency in the hands of the public.

BR - borrowed reserves

factor that determine the money supply. banks borrow funds from the federal reserve. the money supply is positively related.

MBn - nonborrowed monetary base

factor that determine the money supply. open market operations by the federal reserve. the money supply is positively related to MBn.

e - holdings of excess reserves

factor that determine the money supply. the choice of banks to retain excess reserves rather than lend them out. negative relationship

c - currency holdings

factor that determine the money supply. the choice of depositors to hold cash vs. bank deposits. negative relationship.

rr - required reserve ratio

factor that determine the money supply. the minimum amount of checkable deposits that banks must keep in reserve. set by the federal reserve. negatively related.

open market sale

if the fed sells $100 million of bonds to banks or the nonbank public, the monetary base will decrease by $100 million.

what effect might a financial panic have on the money multiplier and the money supply? why?

A financial panic would most likely cause banks to hold more excess reserves. This would cause the money multiplier to decrease and thus decrease the money supply if the Fed did not move the monetary base to offset the change in the money multiplier.

during the great depression years from 1930-1933, both the currency ratio c and the excess reserves ration e rose dramatically. what effect did these factors have on the money multiplier?

An increase in both the currency ratio and the excess reserves ratio resulted in a dramatic decrease of the money multiplier.

the money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. yet the m1 money supply decreased by 25% in the depression period but increased by more than 20% during the recent financial crisis. what explains the difference in outcomes?

During the Great Depression, the Federal Reserve did not expand the monetary base so the decline in the money multiplier resulted in a decrease in the money supply. During the most recent crisis when the money multiplier decline because of the increase in excess reserves, the Federal Reserve increased the monetary base to keep the money supply stable.

M = m(MB)

M = the M1 measure of the money supply m = the money multiplier MB = the monetary base.

the fed buys $100 million of bonds from the public and also lowers the required reserve ration. what will happen to the money supply?

The money supply will increase. The open market purchase causes the monetary base to increase. The lowered required reserve ratio causes the money multiplier to increase. Both of these actions cause the money supply to expand.

reserves

reserves consist of deposits at the fed plus currency that is physically held by banks. reserves are assets for the banks but liabilities for the fed, because the banks can demand payment on them at any time and the fed is required to satisfy its obligation by paying federal reserve notes. an increase in reserves leads to an increase in the level of deposits and hence in the money supply.

criticisms of the simple deposit model

sometimes individuals and businesses choose to hold currency rather than putting the funds into the banking system. sometimes banks choose to hold excess reserves rather than lending out all that they possibly would.

open market purchase from nonbank public

the effect of an open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits. if the proceeds are kept in currency, the open market purchase has no effect on reserves; if the proceeds are kept as deposits, reserves increase by the amount of the open market purchase. the effect of an open market purchase on the monetary base, however, is always the same (the monetary base increases by the amount of the purchase) whether the seller of the bonds keeps the proceeds in deposits or in currency.

open market purchase from bank

the fed purchases $100 million of bonds from banks and pays for them with a check for this amount. BANK: $100 million more reserves and a reduction in its holdings of securities of $100 million. FED: liabilities have increased by the additional $100 million of reserves, while its assets have increased by the $100 million of additional securities that it now holds.

open market operations

the federal reserve exercises control over the monetary base through its purchases or sales of securities in the open market.

loans to financial institutions

the loans they have taken out are referred to as borrowings from the fed or alternatively as borrowed reserves. an increase in loans to financial institutions can also be the source of an increase in the money supply. the interest rate charged banks for these loans is called the discount rate.

simple deposit multiplier

the multiple increase in deposits generated from an increase in the banking system's reserves in a simple model in which the behavior of depositors and banks plays no role.

multiple deposit creation

the process whereby, when the fed supplies the banking system with $1 of additional reserves, deposits increase by a multiple of this amount. a bank cannot safely make a loan for an amount greater than the excess reserves it has before ti makes the loan.

monetary base

the sum of the fed's monetary liabilities (currency in circulation and reserves) and the us treasury's monetary liabilities (treasury currency in circulation, primarily coins). MB = C + R monetary base = currency in circulation plus the total reserves in the banking system.

treasury deposits at the fed

when the us treasury moves deposits at the fed, it cause a deposit outflows at these banks and thus causes reserves in the banking system and the monetary base to decrease.